Financial capability: Managing money and planning ahead

By Marianne Curphey

Whether or not you are financially capable
may seem like a subjective judgment. After all, you might think you're
financially capable as long as you can pay the bills, while your friend thinks
you can't be considered financially capable unless you can pay the bills and have enough saved for at least three
months' worth of expenses.

However, a recent report from the Office
for National Statistics, which studied adults in Great Britain from 2010 to
2012, gives some solid guidelines to go by. It says only one in 100 people
studied are truly financially capable, meaning almost everyone has room for
improvement in at least one area.

The organisation defines financial
capability as "having the skills, knowledge and behaviours needed to make
informed decisions and take positive action about their finances". The ONS measured
capability using six dimensions. It scored individuals on a scale of 0 to 10:

Financial capability:
How do Britons measure up?

This is the first part of a three-part series on financial capability. Check out the rest of the series:

Planning ahead. Brits scored the lowest
on this dimension, with a mean score of 2.3.

Having organised money management. (Mean
score: 6.7.)

Making ends meet. (Mean score: 7.0 --
the highest of all the dimensions.)

Controlling spending. (Mean score: 6.7.)

Staying informed. (Mean score: 3.2.)

Choosing products. (Mean score: 6.6.)

Though the study revealed that certain
groups, such as childless couples
or those in higher socioeconomic groups, did
well overall, every group
suffered in at least one category. For instance, those
with the highest incomes scored well in choosing products and making ends meet,
but not in planning ahead. Those with lower incomes scored the lowest overall,
but did well in money management, presumably because they have to budget more
carefully than people who earn more.

In a short series of stories, UK.CreditCards.Com
will break down each category and what steps you can take to eventually improve
your overall score. We're starting with money management and planning ahead.

Periodic
adjustments are key
One cause for even the wealthiest to fail at good money management is
complacency, according to Justin Modray, financial services expert and founder
of money management website CandidMoney.com. You need to periodically review
your finances and adjust to changing circumstances.

For a lower income household, that routine
might mean putting all money toward bills and debt, and barely having enough to
scrape by until next payday. Higher earners may simply not pay attention to
what they're spending, knowing that their salary is good enough to cover
whatever they need.

"If you don't have much money and are
struggling to make ends meet, then you have no choice but to make your money
stretch as far as it can," Modray says. "However, if you can borrow freely and
know you have the capacity to pay back your debt at some time in the future,
then you may not be so concerned about careful money management."

Look at your budget carefully, says money expert
Lisa Conway-Hughes, an independent financial adviser with Westminster Wealth
Management. Pay attention to which categories of spending eat up most of your
earnings. Remember that your incomings and outgoings aren't the same
year-round. You might get an annual bonus in January or February, but have more
expenses in December. Or perhaps your children are in school autumn through
spring, but you need to pay for extra child care during the summer.

"I recommend looking at your income and
outgoings every six months, and also taking time to draw up an annual budget to
get an estimate of what the cost of holidays, children, eating out and other
expenses are likely to be over the next 12 months," Conway-Hughes says.

Even if you live comfortably enough that
you don't feel the need to use such a fine-toothed comb on your budget, you can
still benefit from it, Modray says. For instance, you might be able to spot
that you aren't getting the best deal on your borrowing, or that you are paying
for unnecessary items.

"For example, you may have set up a credit
card to pay off the minimum each month, when in fact you have sufficient
savings built up to clear the debt in one go and save yourself the ongoing
interest," he says. "If you do still need to borrow, check what interest rate
you are paying and whether that is really the best option; there are plenty of
good deals that you could switch to. Check if you have old direct debits going
out each month for gym memberships or other services and whether you actually
recognise them or need them."

Once you have money management under
control, planning for the future should naturally follow, as you'll discover
exactly how much you have left over for savings, or discover where you can cut
your budget to start a savings. Conway-Hughes suggests using a 30%/70% method
to split up where your money goes.

"Set aside 15% of your income for
retirement planning, 5% on insurance and protection, and 10% on medium-term
cash savings," she says. "Then the 70% that is remaining can be used to pay
your mortgage, and other expenses."

When you have these two aspects under
control, a third will naturally start fall into place: living within your means,
says Nick Hill, proposition and product development manager for the Money
Advice Service. In other words, a detailed, dynamic budget is a powerful tool
in boosting your financial capability.

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